Investing - Things I Have Learned in Retirement
This is complicated. And details change every year. And I don't know all the details. So I am going to outline concepts, not specifics.
401K to IRA Transfer
This can be done without penalty or taxes after you reach 60 years. The advantage is that you have more control over your assets. But it may take you out of some handy mutual funds or useful benefits. For example, stable value funds were designed for 401ks, and are not available for IRAs.
Do a direct transfer to your brokerage (or read the rules carefully to avoid a trap).
IRA to Roth IRA
You can invest in a Roth IRA only with income that you have payed taxes on. There is no income tax on Roth IRA withdrawals (but read the rules on how long you have to wait before withdrawals).
You are allowed to move assets from an IRA to a Roth IRA. There are currently no limits on your income or the amount of assets that you can move. You must pay income tax on the value of the assets that you move. Have your brokerage do a direct transfer (or read the rules carefully to avoid a trap).
This will increase your income. So look at how it affects your taxes, Medicare payments, maybe other things like COVID relief payments, student loan relief.
The advantage of doing this is that it shields you from future tax increases and the Roth is a good place to put high risk/reward investments because they grow tax free.
Social Security Income
It's well publicized that your Social Security income depends on when you start taking payments. A first approximation is that if you live past 84, you will get more money if you delay payments. This is a choice only if you don't need the money immediately, so it depends on what you do with the money - spend or invest.
There are many reasons to handle this in different ways - income taxes, the availability of other income sources, ability to spend money as you get older.
Required Minimum Distributions
Somewhere around 70 years age (72 right now), there are required minimum distributions on an IRA, 401k (I think any tax advantaged account made up of pre-tax income). It is your responsibility to initiate these withdrawals. The penalty for missing these is huge. You cannot count IRA to Roth conversions toward this withdrawal.
Taxes (revised 2023-09-14)
I'm not a tax expert. Where you withdraw money (IRA, Roth IRA, tax unadvantaged assets) and how much you withdraw affects your tax rate. Note the difference in ordinary income, capital gains, dividends, and interest. Use this to your advantage.
IRA - ordinary income tax
Roth IRA - no tax
bond interest - interest tax
sold stocks - capital gains tax
stock distributions - dividend tax
stock fund distributions - cap gains tax, dividend tax
bond fund distributions - cap gains tax, interest (reported as ordinary dividends) tax
fund withdrawal - capital gains tax
Dividend taxes - dividends can be "qualified" or "unqualified ordinary". Qualified dividends are a subset of ordinary dividends. Qualified dividends are taxed as long term capital gains. Unqualified ordinary dividends are taxed as income. The rules for a dividend to be qualified are a bit detailed - search on "qualified ordinary dividends", but in general, dividends from a US corporation that you have held long enough are qualified. The year end brokerage tax summary lists total ordinary dividends (includes qualified) and qualified dividends.
Capital gains taxes - capital gains can be short or long depending on how long you held the asset before selling. Short term gains are taxed as income. Long term gains get the long term capital gains rate.
There are just two rates (actually rate tables). Income, interest, unqualified ordinary dividends, and short term capital gains get the income tax rate. Long term capital gains and qualified dividends get the long term capital gains rate.
As I understand it - for Kentucky, the first $31,000 of retirement income (IRA, 401K, etc. withdrawal) is free of Kentucky income tax (2020, changes every year). This includes an IRA to Roth conversion.
The homestead tax exemption varies by state. In Kentucky it reduces the taxed value of your home by about $39,300 (2020, changes every year) for people at least 65 years old. You must apply to get this exemption.
Tax Unadvantaged Assets
That is stuff that is not in an IRA, Roth IRA, 401K, 403b, etc.
If you have assets that are not tax advantaged, when you withdraw money from these assets you pay capital gains taxes on the difference between the current value and the cost basis. This can be considerably lower than paying income taxes on an IRA withdrawal. So this may be where you want to take money to live on.
(If you have a Roth IRA, there is no tax on a withdrawal. But that's a great place to grow assets for the future.)
Every year, or maybe quarterly or monthly, a mutual fund makes a distribution to cover the capital gains on stocks that it sells and dividends that it has collected. The distribution is a combination of capital gains and dividends, and you pay taxes based on that. If you have the mutual fund set to reinvest distributions, the money is used to buy more shares (this increases the cost basis, assuming the funds assets are growing, and reduces future taxes). If you then take a withdrawal for living expenses, you pay capital gains taxes on the withdrawal. So it is likely preferred to turn off automatic reinvestment, and use the yearly distributions for living expenses.
Indexed Funds vs Managed Funds
If you have a tax unadvantaged mutual fund with a low cost basis (often due to many years of ownership), it may be very expensive to sell due to the capital gains taxes. So what do you do if you suddenly find the fund falling significantly faster than its benchmark index due to a manager change or the manager's luck? I don't know. But this is one BIG reason to stick with index funds. You may miss out on some appreciation that a genius fund manager can offer, but you also miss out on the death spiral of an unlucky manager or a bad new manager.
Also, since index funds seldom sell stocks (the indexes are pretty stable), the capital gains distributions are low. Of course that means that the cost basis percentage goes lower more quickly. So the index fund is more expensive to sell (high capital gains taxes). But, especially for a dividend fund, you may never have to sell.
Asset Value vs Income
Stocks return dividends based on profit, without regard to the stock value. So if you invest in dividend stocks to get dividends, you do not need to be concerned about the stock's price. To a point. If the profits drop, the dividends will drop and the stock price will drop.
But the point is, to a degree, dividend stocks and funds can be a good income source despite being subject to stock value fluctuations.
Similarly bonds and CDs give off a steady dividend despite their value fluctuating with current interest rates. Bonds and CDs held to maturity hold their initial dollar value. Bond fund values fluctuate with interest rates because they reflect the current value of the bonds.
Medicare charges you more if your income is too large, first increase at a little over $100,000 I think. If you take a lot of money from an IRA, for living or transfer to Roth, you can expect this hit in two years (as I understand it).
These are just funds to look into. I am not making any recommendations.
dividend stocks - VYM, SCHD
60/40 stock/bond funds - VBIAX, PRWCX, VWELX
40/60 stock/bond funds - VWINX
intermediate bonds - DODIX, VCORX
short term bonds - FNSOX
CDs - 3%, 3 years looks good